Brief:- Mumbai Income-tax Appellate Tribunal (“the Tribunal”) in the case of Devendra Motilal Kothari Vs. DCIT  50 DTR 369 (Mum), has held that fees for portfolio management services (“PMS”) are not inextricably linked with the particular instance of purchase and sale of shares and hence cannot be allowed as a deduction while computing capital gains.
Facts :-The assessee had entered into an investment management agreement with four parties and had incurred portfolio management fees. The PMS fees were claimed by the assessee as part of the cost of the acquisition of shares while computing capital gains.The Assessing Officer (“AO”), however, held that PMS fees are not part of the cost of acquisition of shares and securities, and hence, not allowable as a deduction.Against the said order of the AO, the assessee preferred an appeal before the Commissioner of Income-tax (Appeals) (“CIT(A)”).The CIT(A) held that the PMS fees paid by the assessee have no connection with the acquisition, or transfer, of specific shares. It is just not possible to break up the fees paid by the assessee so as to hold that the expenditure is incurred solely for the purchase or transfer of shares and securities. It also held that since the PMS fees were payable on interest and dividend income as well, they were not exclusively for the acquiring or selling of shares. Against this order of the CIT(A), the assessee preferred an appeal before the Tribunal.
Assessee’s contentions :- PMS fees form part of the cost of acquisition, and therefore, should be taken into consideration while computing capital gain. The services of the investment manager were used to obtain an advice about the purchase, sale or retention of particular shares or securities. Hence, the payment of PMS fees was in connection with acquisition/improvement and sale of an asset. Without prejudice to the above, PMS fees were deductible on the basis of real income theory and diversion of income by overriding title since the PMS fee is in the nature of a charge against sale consideration. Based on various judicial precedents, PMS fees are allowable as deduction against capital gains.
Revenue’s contentions :- PMS fees were paid based on the market value of the asset or net value of the assets at the beginning or end of each quarter. A substantial amount of PMS fees would have been payable even if no purchase or sale transaction had been carried out during the year. The provisions for computing capital gain are specific and real income theory cannot be applied to it. The case laws relied on by the assessee are distinguishable on facts.
Tribunal Ruling :- Under section 48 of the Income-tax Act, 1961 (“the Act”), only expenditure incurred wholly and exclusively in connection with transfer and acquisition is deductible. The appellant failed to explain how these expenses can be treated as incurred wholly and exclusively in connection with the sale of shares. There is no explanation of how these expenses can be allocated among various securities. PMS fees are not inextricably linked with the particular instance of purchase and sale, hence not incurred wholly and exclusively in connection with the sale or the cost of acquisition, or improvement. Accordingly, PMS fees are not deductible under section 48 of the Act. The test for determining the rule of diversion of income by overriding title is to know whether an obligation is in the nature of a charge on the source. Payment of PMS fees is an obligation to the charge and not to the source. The theory of real time income cannot be applied to justify deductions which are otherwise not permissible under the Act.
Conclusion :- The Tribunal’s decision will have a far reaching impact on investors investing in various funds. According to industry practice, 2% management fees are paid to portfolio/fund managers. Such fees are unlikely to be allowed as deduction to investors considering this decision.